Macaskill on markets: SoFi farce comes close to fintech tragedy
The departure of SoFi founder Mike Cagney as CEO should serve as a warning against believing the hype about fintech firms without testing the self-interested assertions of their managers.
Euromoney drew attention to some curious aspects of Cagney’s background in June 2016. He had generated marketing buzz about SoFi’s goal to expand beyond online student lending with a campaign of blustery Twitter posts and grandiose statements in interviews at conferences. So far, so fintech, with Cagney appearing to emulate the success of Donald Trump in attracting free publicity.
Cagney’s description of his own background as a trader at Wells Fargo was both detailed and unconvincing, however. He wrote in his employment summary on website LinkedIn that he started and managed the financial products group at Wells Fargo and delivered impressive sounding results.
“I managed a $25 million daily VaR, and our proprietary trading consistently produced high double- to triple-digit returns on risk capital,” Cagney said.
As Euromoney pointed out, that would have been an extraordinarily high daily value at risk (VaR) for a trading desk at a bank that was not active in investment banking when Cagney was an employee between 1994 and 2000. Consistently high double- to triple-digit returns would also have marked unusually strong performance by Cagney, and senior officials familiar with the financial products group at Wells Fargo at the time did not recall either its risk limits or returns matching the levels he claimed.
Just over a year after we highlighted the potential inconsistencies in Cagney’s version of his triumphant rise, he was forced to resign as CEO of the firm he founded. The proximate cause of his departure was a growing scandal around allegations of sexual harassment at SoFi.
Cagney has admitted no wrong-doing, but did say that “the combination of HR-related litigation and negative press have become a distraction from the company’s core mission.” He added: “I want SoFi to focus on helping members, hiring the best people, and growing our company in a way consistent with our values. That can’t happen as well as it should if people are focused on me, which isn’t fair to our members, investors, or you.” That appears somewhat ironic given Cagney has seemingly revelled in a cult of personality around SoFi’s supposed successes, which helped attract big investments from the likes of SoftBank and Silver Lake Partners.
Regulators, investors and buyers of SoFi’s structured debt came perilously close to further embarrassment, as the firm had appeared to be on the brink of obtaining a banking licence when Cagney was forced to resign in September.
In June, SoFi applied to the Federal Deposit Insurance Corporation for a special banking charter from the state of Utah. SoFi hoped to qualify as an industrial loan company so that it could make loans and accept insured deposits like a regular bank but without being subject to supervision by the Federal Reserve.
This was a characteristically brash bid by a firm that Cagney had previously positioned as the antithesis of a mainstream bank in his hyperbolic marketing efforts.
SoFi under Cagney displayed an appetite for opaque structures that was also redolent of the worst practices of the financial markets before the credit crisis
SoFi’s banking licence application ran into opposition from the Independent Community Bankers of America, a trade group for small banks, which argued that the online firm was trying to access the federal banking safety net while dodging compliance with the regulations faced by normal banks.
SoFi nevertheless probably hoped that its application would succeed in the Trump era of relaxed regulation.
Trump’s economics team in Washington, led by Goldman Sachs veterans Gary Cohn and Steven Mnuchin, has not made any progress in reversing the Dodd-Frank legislation of 2010 that tightened financial market regulation. But the administration has signalled that in financial matters – as in other areas – it intends to appoint regulatory heads who will take a laissez-faire approach to supervision where possible.
Cagney’s departure from SoFi, along with the resignation of former chief financial officer Nino Fanlo and other top executives, may have ended any prospect of the firm winning a banking licence in the near term. Management stability is one of the criteria considered by regulators when granting a licence – and SoFi certainly fails on that count.
SoFi is being run temporarily by executive chairman Tom Hutton, one of the original investors in the firm, while the board looks for a new CEO to replace Cagney. Fellow board member Steven Freiberg, a former CEO of E*Trade and head of Citigroup’s global consumer group, is acting as CFO and presumably providing some supervisory comfort for investors as SoFi tries to correct course.
So what will it take for Hutton and Freiberg to rescue their investment – SoFi was nominally valued at over $4 billion before its recent woes – and pursue the long-term goal of an IPO?
A new management team will need to address reputational issues as a priority. This should involve a thorough overhaul of risk management practices, as well as a comprehensive examination of the background of any new managers who are hired.
While SoFi 2.0 can expect added scrutiny from existing investors keen to avoid losing all their money, it will probably not face much push back from buyers of its structured bonds. Asset-backed securities buyers are showing worrying signs that they have either forgotten the lessons of the approach of the credit crisis 10 years ago, or are too young to have learned them in the first place.
When Goldman Sachs was marketing a repackaging of SoFi loans in September, just as Cagney was being pushed out as CEO, it made some cosmetic tinkering with the terms of the deal. The size of the bond was reduced slightly to $527.1 million and the spreads on offer were widened by roughly 10 basis points, depending on the tranche.
This was more than enough to ensure a smooth sale of the debt to buyers who demonstrated a ‘what? me worry?’ approach reminiscent of the cresting of the wave for the structured credit markets in 2006 and 2007 that preceded the global financial crisis of 2008.
SoFi under Cagney displayed an appetite for opaque structures that was also redolent of the worst practices of the financial markets before the credit crisis.
It set up a credit hedge fund designed to buy its own loans, for example, in a move that was almost comically fraught with obvious conflicts of interest. It is not clear whether this fund ever raised enough capital to buy many loans, or whether Cagney had or retains any financial interest in its performance, and SoFi did not respond to a request for comment.
The SoFi farce may have played out quickly enough to avoid turning into a financial market tragedy, but it will hopefully still teach some lessons to the more gullible members of the fintech audience.